The recent reports of significant price increases for certain medications have ignited, yet again, calls for pharmaceutical price controls. If implemented, price controls will reduce medical discovery and diminish patients’ access to life saving medicines.

Pharmaceutical innovations help patients and strengthen the U.S. economy

Pharmaceutical innovations are improving the quality of life for many patients. Advances in HIV-Aids medicines, for instance, can now help patients effectively manage a once fatal disease empowering them to live long and healthy lives.[i]As another example, according to the American Cancer Society, advances in pharmaceutical therapies are improving the quality of life for cancer patients and improving patients’ survival rate. Thanks to these innovations, between 1991 (the peak in the cancer death rate) and 2010 the cancer death rate has fallen 20 percent.[ii]

Pharmaceutical innovation is also an important economic driver. According to PhRMA, the trade association for the pharmaceutical industry, the U.S. pharmaceutical industry employs over 800,000 people paying, on average, more than double the average compensation for U.S. workers.[iii] In total, the industry is responsible for over $790 billion in economic activity annually.

These health and economic contributions will only continue if the innovating manufacturers are provided opportunities to recoup their costs of capital. Price controls limit the ability for innovators to recoup their costs and therefore reduce the amount of pharmaceutical innovation.

Innovation does not come cheap

Developing a new pharmaceutical drug is an expensive process that is fraught with failure. These costs include the billions of dollars in outlays, the years it takes to develop a new drug (estimated to be between 10 to 15 years), as well as the large risks of failure.

Estimates of the actual dollar outlays (the direct expenditure costs) vary.  On the lower end, and including the expenditures on the drugs that were unsuccessful, the development of a new patented pharmaceutical can cost $1.3 billion.[iv]  On the upper end, and including the expenditures on drugs that were unsuccessful, the total R&D cost per drug were estimated between $5.5 billion and $5.9 billion.[v] These expenditures are not what the industry must repay, however.

People will not invest in (or lend to) the innovative pharmaceutical industry if, after bearing all of the risks of developing a new therapy, they are only returned their original investment. Instead, the pharmaceutical industry must pay investors a competitive return on the money invested – adjusted for the risks of failure and the long time it takes to develop a new drug.

It is only possible for pharmaceutical manufacturers to bear these costs, and invest in pharmaceutical innovation, if the revenues generated from drug sales equals the company’s total capital costs. Price controls, by definition, limit the revenues that can be earned from developing innovative therapies and therefore limits the total amount of capital costs that innovative manufacturers are able to recover. By capping drug prices, policymakers are, consequently, effectively capping innovation and jeopardizing the tremendous health and economic benefits that the pharmaceutical industry has been creating for decades.

The disincentive from price controls particularly stifle innovation for neglected diseases that afflicts only a small number of patients (also known as orphan diseases), or therapies that are riskier and more expensive to develop. Price controls will likely result, consequently, in less innovation in many of the most needed therapeutic areas.

A systemic approach to managing growing health care costs

Advocates of pharmaceutical price controls also misunderstand the fundamental problem that needs to be addressed: overall healthcare inflation that is excessive and without an equivalent increase in the quality of service. Skyrocketing overall healthcare inflation is not due to spending on pharmaceutical drugs, however.

Total pharmaceutical spending accounts for less than 10 percent of total U.S. healthcare expenditures, and, perhaps most importantly, according to the Centers for Medicare & Medicaid Services National Health Expenditure Projections, pharmaceutical spending will remain at, or below, its current share of total healthcare spending through 2022.[vi]

It is, therefore, a mistake to focus cost control measures on pharmaceutical spending. Healthcare expenditures, just like patients’ treatment plans, should be viewed systemically.  Spending more money on one therapy that improves patient outcomes and drives down overall health expenditures is a sign of efficiency, not a problem that needs to be addressed.  And, the evidence shows that pharmaceutical drugs create better patient outcomes while reducing overall healthcare expenditures.

Pharmaceutical drugs will often reduce the total amount of money spent on hospital and other medical costs due to more effective disease management.  For example, with respect to Medicare spending, one study found that a $1 increase in prescription drug spending was associated with a $2.06 reduction in overall Medicare spending.[vii] Another study published in the Southern Economic Journal found that “the typical new drug slows the growth of overall medical care spending.”[viii]

Conclusion

Spending on pharmaceutical drugs is not driving the healthcare inflation problem. In fact, pharmaceutical innovation is part of the solution. Pharmaceutical innovations reduce overall healthcare costs and improve overall healthcare quality.

While distorted by excessive government regulations, the economic fundamentals of supply and demand drives the pharmaceutical industry. Innovation is only possible if the revenues for innovators covers the capital costs they incur.

Consequently, when policy makers cap drug prices, they are also capping innovation. With less pharmaceutical innovation, there will be fewer health benefits for patients, greater pressure on overall health care inflation, and fewer economic contributions from the pharmaceutical industry.

 

Wayne Winegarden, Ph.D is a Sr. Fellow at the Pacific Research Institute, a Contributing Editor to EconoSTATS a project of George Mason University, and a Partner in the consulting firm Capitol Economic Advisors.




[iv] DiMasi Joseph A. and Grabowski, Henry G. (June–August 2007) “The Cost of Biopharmaceutical R&D: Is Biotech Different?” Managerial and Decision Economics, Vol. 28, Nos. 4–5, pp. 469–497; (2013) “2013 Profile: Biopharmaceutical Research Industry” PhRMA July.

[v] Herper, Matthew (2013) “The Cost of Creating a New Drug Now $5 Billion, Pushing Big Pharma to Change” Forbes.com, August 11; www.forbes.com/sites/matthewherper/2013/08/11/how-the-staggering-cost-of-inventing-new-drugs-is-shaping-the-future-of-medicine/.

[vii] Shang, Baoping and Goldman, Dana P. (2007) “Prescription Drug Coverage and Elderly Medicare Spending” NBER Working Paper 13358, September; www.nber.org/papers/w13358.

[viii] Santerre, Rexford E. (2011) “National and International Tests of the New Drug Cost Offset Theory”, Southern Economic Journal: April 2011, Vol. 77, No. 4, pp. 1033-1043.

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